Why Japanese VCs are Losing Out – James Riney of 500 Startups

500 Startups has been one of the driving forces behind the utter disruption of how seed funding is done. That shift is one of the reasons we have seen such large and diverse startup ecosystems emerging around the world. Japan, however, often changes more slowly than other nations.

Today we sit down and talk with James Riney, the new head of 500 Startups Japan, about why Japanese venture capitalists have been so slow to change, and exactly what James and 500 Startups plans on doing about it.

Things are already changing for the better in Japan — at least as far as startups are concerned — but if Japan’s traditional venture capitalists don’t change their ways, they are going to find themselves locked out of the most important deals. Seed stage investment is increasingly a sellers market, where quality startups pick between competing investment firms. It’s a new dynamic that many VCs here are struggling with.

We talk about the most important things a VC can offer its portfolio companies, and I’ll leave it to you to decide if Japanese investors are ready for it.

Transcript from Japan

I am Tim Romero and thanks for listening. It’s safe to say that almost all of Disrupting Japan’s listeners know about 500 Startups. It’s also safe to say that very soon you will be hearing a great deal from James Riney as well. Now, James is the head of the fledgling 500 Startups Japan and as some optimistic, but very well founded ideas about how both Japanese startups and Japan in general is going to change in the next few years. We talk about his narrow escape from a life in investment banking, to his startup and breakup with his cofounder, to finding himself at the helm of 500 Startups Japan.

We have a pretty frank discussion about the state venture capital in Japan today and it’s not pretty. But, we also talk about how many of these problems are starting to be resolved and how James and 500 Startups plan on disrupting things here in Japan. We talk about how to increase M&A activities in Japan, why Japanese VCs are starting to lose out on the best deals, and why they are going to continue to lose out until something changes. Also, what Western VCs secret weapon really is and I promise, it’s not what you think.

I don’t want to spoil any of the surprise. It’s best if you hear it from James personally. So let’s get right to the interview.

Tim: I am sitting here with James Riney, the head of 500 Startups Japan. Thanks for coming in and sitting down and talking to us.

James: Thanks for having me.

Tim: Excellent. Now, before we get into talking about 500 Startups, which is pretty much your life at the moment, talking about 500 Startups.

James: That’s my job.

Tim: Let’s talk about you, how you sort of got here. You grew up in Japan, didn’t you?

James: That’s right. I grew up in Japan. I was here until I was about twelve years old. I went to ASAJ, American School in Japan. I left and I went to Florida. I had pretty much forgotten all of my Japanese. I didn’t have any opportunities to speak Japanese. Somehow, when you learn it as a kid, the core is still in there, right?

Tim: Right.

James: So when I got into the university, I started studying again. It came back to me pretty quickly, because as I said it seems to be when you learn as a kid some fundamentals are there.

Tim: Yeah.

James: I was not sure what I wanted to do, frankly. So I decided to do JPMorgan, just purely for the brand name basically. I had no idea what I wanted to do. So I interned in New York originally and then towards the end of the internship they said that they were going to give me an offer and so they gave me both offers. I chose Tokyo.

Tim: Alright.

James: So when I graduated right away I went to Tokyo and I started at JPMorgan and I realized that investment banks weren’t for me, right away.

Tim: Yeah, yeah. In fact, I think a large percentage of the people still working in investment realize that investment banking is not for them.

James: Yeah. Well there is very few that actually are lifers, right? They stay forever. Usually it’s kind of like, you do your time and you go onto bigger and better things or at least more tolerable things.

Tim: Well, in your bigger and better thing or perhaps a smaller and better thing,

James: Yeah.

Tim: Was that you were co-founder of Stories JP?

James: That’s right.

Tim: Right?

James: I met my co-founder at JPMorgan.

Tim: Yeah, you were both from JPMorgan?

James: We were both from JPMorgan.

Tim: Now Stories it’s kind of like Medium, but it’s based on Fiction, right?

James: So it’s your personal stories. The idea is that the Japanese blogging space, it’s very, pretty much like anonymous and we thought that it would be interesting to have something that was more tied to your real name. So we required a Facebook log in. The idea actually didn’t start out as Stories by JP. We didn’t really know what to make. We would just hack away at things. I learned how to code front end and he was doing the back end.

Tim: Ah.

James: You know, I just learned Photoshop, you have to right?

Tim: Yeah.

James: Because you just want to make things so we made a few things and then we pitched at Startup Weekend actually. Just by chance, there were like three people from JPMorgan so only 3% were like oh you’re from JPMorgan, you’re from JPMorgan, and we discovered it there.

Tim: I guess a lot of people were realizing that investment backing was not for them.

James: Yeah. It’s not what it used to be, right? When we pitched, Wada-san from Inncubate fund approached us, so over the course of the next six months or so, that’s when we started negotiating the actual investment. In retrospect it probably was not good terms, but I was so naive it was my first time out.

Tim: It was the first time out right?

James: It was the first time out I was like, okay, yeah, someone going to give me money? Okay great! We started out with something that was like a video résumé and the idea was that there is a lot of demand for bilingual talent.

Tim: Mm-hmm.

James: You don’t really know if this person can actually speak. So let’s say you were filtering résumés, you narrow that down to thirty, but how do you narrow it down from thirty to ten for example? A video résumé can be that quick and efficient way to say, “Okay, this person is native.”

Tim: So is the pivot away from video résumés into storytelling is that before the funding, after the funding? At what point did you actually realize that it’s time to change?

James: Actually, after the funding. The reason was because we felt that it would be very hard to execute because as you know, recruiting, let’s say might be or might not be included that feature and into their platform. I mean it’s very hard to build a business based on a feature rather than something that is a little bit more disruptive, right?

Tim: Well that’s a really interesting point. In fact, I think a lot of the startups coming out of San Francisco today; there are a tremendous number of kinds of features for startups.

James: Yeah.

Tim: Companies that are obviously focused on like, “We’re going to get acquired.”

James: Yeah.

Tim: This cannot survive as a stand-alone product.

James: Exactly.

Tim: Majority, you don’t see that in Japan. It might just be the M&A is just not as active here.

James: Yeah. I think that is very true. I mean it’s very doubtful that recruit would acquire rather than build that in-house, right?

Tim: Yeah.

James: Right. So anyways, we were thinking of, what can we make that even if a big company does it, it’s not going to matter? And so, one thing we thought that was missing was a LinkedIn for Japan. As you know LinkedIn still hasn’t picked up in Japan.

Tim: No.

James: We were thinking, okay, well what is something that is very, very core to Japanese culture and that’s the exchange of business cards. When we started out it was supposed to be like 名刺に乗らないストーリー which is a story that doesn’t fit on your business card.

Tim: So it’s still business focused?

James: It was business focused, but the idea was that you would have you’re URL there and on there you would just write your stories, like there was this one sales goal that I had to make, and some, yeah.

Tim: Yeah, I get it.

James: You know people blog and talk about that stuff all of the time.

Tim: Sure.

James: So we thought that if it was framed in a different way, you can get the same data, but it’s not seen as like, the boss thinking you are trying to change your job or something like that.

Tim: Yeah, it’s a more social network, storytelling. So how did that play out?

James: Yeah. So we went to private beta with that, but what we realized was that all of these other features, we basically built a LinkedIn plus blogging, which no one has by the way. What we found was other people were just using the story feature and not really feeling out their other details. So the goal of getting that data was pretty much, you know, we didn’t accomplish it. Eventually we just said, okay why don’t we just scrap everything and just go with the story writing feature.

Tim: If your customers are telling you what they like about your product, it’s good to listen to them.

James: Exactly. So that’s what we went with. We changed the name. We said, okay it’s going to be Stories by JP. We actually were able to get 100, 000 uniques pretty quickly and so it seemed like it was going pretty far.

Tim: Some of the bloggers got publishing deals from that.

James: Yeah, yeah, exactly.

Tim: It had quite a social impact.

James: The biggest one that came out is the birigaru story, the girl that was not necessarily the best student in High School, but she worked hard and she got into KO, which is one of the best universities here. So that is, you know, like a big hit, I mean number one best seller on Amazon in Japan and it went on to become a movie and so it grossed about $23 million dollars at the box office.

Tim: Did Story JP make any money off from that?

James: I cannot disclose.

Tim: Okay.

James: But, that stuff is like gaming, right? It’s a hits driven business and so it’s very hard to build a stable business out of that. There came a point where we were thinking, because we need to think of something that’s a little more sustainable and between the founders we just didn’t see eye to eye. I mean, one core thing was that I wanted to build something a little bit more of a global impact and co-founders were purely Japanese, my investors are Japanese, so I just didn’t see how this was the team to accomplish what I wanted to accomplish. Fortunately I was still on good terms with my VC which is Inncubate Fund, and one of the LPs in Inncubate Fund was DeNA. Right around that time DeNA was launching their own venture arm and so that’s basically when I joined. I joined right at the inception.

Tim: Now Stories JP is still an ongoing concern, right, it’s still operating?

James: Yeah and it still brings in pretty good traffic.

Tim: It’s, well, content is hard.

James: It is hard, exactly.

Tim: So when you moved from being startup to being a VC, that’s a big change. Do you find being on the VC side of the table more suitable? Do you like it better? Do you miss getting your hands dirty in the fray of the startups?

James: Okay, so as an entrepreneur you get all of stress and all of the glory.

Tim: Mm-hmm.

James: When you’re a VC all of the stress and all of the glory is in portfolio and it’s, you know, diversified so you don’t get as much glory, you don’t get as much stress.

Tim: Alright.

James: So, you know, it’s worth the trade off right? Okay, what I miss about running a startup is that when you’re a VC you don’t really call the shots and so you can give as much advice as you want, but at the end of the day it’s the entrepreneur’s company and so you just have to dish out advice when it’s welcomed and then you just kind of got to let him be. That is a concern, especially for someone like me that’s a little more direct and to the point and very, I can be abrasive sometimes.

Tim: Now this is one thing I’ve noticed in Japan, one of the biggest difference in relationship between VCs and the founders, a lot of VCs in Japan expect the founders to take their advice. A lot of the founders, because of this hierarchical relationship almost view their investors as, not exactly their boss, but someone who they almost have to listen to.

James: Yeah. That’s very true and that’s something that we would like to disrupt, for a lack of a better word. We want to disrupt that in Japan because most of the VCs here have no entrepreneurial experience, they’re mostly from finance backgrounds, and they’ve never launched a product on their own. If they have it’s been within a large organization. They seriously lack not only experience, but just empathy, for entrepreneurs, because they’ve never been really under those harsh conditions. So, there is sort of this, like power dynamic where there’s in some sense like a lack of respect for entrepreneurs especially in the days where they’re not necessarily doing so well and that’s pretty key, right? When you have an investor, especially if it’s your main investor, you want that person to be with you through thick and thin.

Tim: Right.

James: I’ve had firsthand experience where I didn’t feel that was the case. I think you may find, yes, but I had one other investor who seemed like when things are great he was my best friend, when things are not so great, I mean, you never hear from him. You know?

Tim: Yeah. I’ve had that experience myself.

James: Yeah and so you don’t really want fair-weather friends and so that’s another pimp friend. You’re right, I think that tends to be the case where the power dynamic is very uneven in Japan.

Tim: Is that changing? Are VCs trying to have more empathy? Or do they even recognize this as a problem?

James: Okay, the reason that Silicone Valley is what it is today, is because it has a culture of given back and that started a long time ago so people like to compare Tokyo to Silicone Valley and that’s fine, but they compare it based on what it is now and they don’t necessarily consider the fact that it’s taken so long to build that up and it’s been decades of this sort of giving back attitude. Whereas in Japan the entrepreneurs that actually made it don’t necessarily give back. In Silicone Valley it’s very common for the established entrepreneurs to actually become VCs, whereas here it gets almost like, as long as you didn’t make any serious mistakes you get to become a VC. Right?

Tim: Right, it doesn’t risk aversion is one of things that you really want in a VC, right?

James: Yeah, yeah so I think that’s a serious problem as to why some of the VCs in Japan are the way they are.

Tim: It is a serious problem. So right now we are starting to see angels, you know, successful entrepreneurs who have been successful who are making small investments to mentor the next generation. Do you think that is going to bubble up into the VC community?

James: Yeah.

Tim: Or do you think they’re pretty set in their ways?

James: First of all, I hope so. What I will say is that the VC community in Japan is mostly corporate.

Tim: Right. Yeah I read an article about that.

James: You may have seen my TechCrunch article about that, but in general the best scenario would be that the established entrepreneurs would join independent VC firms so that you can bring a little bit more of that entrepreneurial flare to those firms. It’s okay if they failed. In my case I wouldn’t necessarily say I failed, but I definitely wasn’t like a mega success, but I’ve noticed that I’ve at least made that transition to VC. At least I can have some sort of empathy or understanding of what they are going through.

Tim: Yeah.

James: I kind of get it.

Tim: Yeah.

James: I’ve noticed that I have entrepreneurs understand that I get it.

Tim: Do they corporate VC recognize this as a problem? Do they recognize the fact that they need this entrepreneurial experience? Or that haven’t had that awakening yet?

James: Well, I think it’s going to take another VC to disrupt that and create the awakening, you know? Good morning.

Tim: So they will realize it’s a problem when they start losing deal flow?

James: Exactly. I’m confident that will happen pretty soon.

Tim: Okay. That is something to look forward to.

James: Yeah.

Tim: So, 500 Startups, you guys are planning to disrupt Japan from the VC side. What is the basic strategy? Are you seed? Only? Are you help to fill in some of the series A crunch?

James: Well, seed to series A, and you know, a lot of people have asked us are we really going to do 500 Startups in this fund, you know.

Tim: It’s just a name.

James: It’s just a name, but the general idea is that portfolio diversification at the seed level, but we invest 50% on first checks and then the remaining 50% is follow on for the best performing deals.

Tim: Okay. At DeNA, you were focused mostly on startups outside of Japan, some in Southeast Asia and in the US, so 500 Startups Japan is exclusively Japan?

James: Yes, exclusively Japan.

Tim: Do you think that you will be able to find the same number in quality of startups here in Japan with smaller market as you were able to when you were looking globally?

James: Okay, yeah, that’s a really good question. First of all, I think that in Japan there are very good startups and there are also very smart people that can potentially startup in the future, right? So the minority exists, and I think the number of high quality startups is increasing. I’m not sure if you read my blog post about joining 500 Startups.

Tim: I did.

James: But you know I talk about how the people that are just coming to work for us now, they never had this sort of image of a stable, big, Japanese company and they are growing up in the lost decade, they are seeing big companies like Sharp doing massive lay-offs and so,

Tim: So the whole risk, reward equation has changed now.

James: Yeah, it doesn’t make sense, right. That’s definitely from your blog post that I took, I thought that was exactly well articulated.

Tim: No, I’ve stolen plenty from you as well.

James: Yeah, exactly, no, I mean it’s the people that live in Japan, but also have a global perspective are just like screaming until their voice goes out about similar problems. But, if you look at examples between the number of founders from like ? University and Tokyo University it’s significantly increased in recent years. I actually do think that you’re going to see that effect, but what is going to serve as a catalyst for that exits, right?

Tim: Yeah.

James: In order for the ecosystem to work you have to have the exits. In one year, generally there is like one hundred IPOs right? The M&A is really where the system gets working because the best companies might to IPO, at least in the US, in Japan I know it’s different because IPO is like series B here, but you know they are still very good companies that are maybe cannot be sustainable on their own, but they would be worth acquisition targets.

Tim: Well this actually brings us back to what you were saying back at there has been this culture in Japan for, well probably since the war quite frankly, companies don’t do M&A, they’ve been focused on maximizing the number of current employees so if they see a product they like they will set an internal team on copying it.

James: Yeah.

Tim: Developing it.

James: Yeah, yeah and that rarely goes well.

Tim: Yes, it rarely does. Is that starting to change? Changing that culture is what will lead to a booming M&As.

James: Yeah. So the new big tech companies, like DeNA or Mixi For example, they are recognizing that and they are actually doing the bulk of the acquisition. That’s right.

Tim: They are pretty acquisitive.

James: They are. The analogy that I like to make is that when you start a new business inside of the large organization that’s public, for example, because big companies have to answer to the shareholders they’re not necessarily looking at long-term, they are looking very, very short-term.

Tim: Next quarter still …

James: If you start one in a large organization you only have one investor. If that one investor says no, you’re screwed, right? Whereas if you start it independently you have many investors to give you a chance and so the longevity you can think much more long-term.

Tim: The advantage of doing it outside of the company is just so strong.

James: It is. Well you get to move quickly, but I do think that the investor part is quite important because I’ve seen examples, which I won’t name specifically, where it’s like, this could’ve been big but you shut it down in eight months.

Tim: Yeah.

James: This was an ambitious thing and to give it more time to sprout.

Tim: That is the funny thing is overseas, particularly in America, we view Japanese cooperation’s as having a really long-term view and willing to endure a few bad quarters for a long-term, but they are really not. They manage a normal quarter just like everyone else.

James: That’s definitely not the case now.

Tim: Maybe it was like that in the 60s.

James: Yeah.

Tim: But not anymore.

James: Yeah, the new large companies are doing acquisitions, however, I think that we need more and that’s where I think that 500 Startups can really help. In general, the Japanese startup system doesn’t have a lot of global visibility from a foreign investor’s perspective. It’s like, okay I know Japan is the third largest economy in the world, but I don’t know anything about the market because I can’t read any of that information.

Tim: It’s a very opaque market.

James: It’s an opaque market and some stuff is just not even written in the first place, right? Just by us having invested in a company, it’s a globally recognized brand, and so it’s more likely to be covered by foreign media. So I think that’s going to build more optics into the ecosystem here.

Tim: Alright.

James: And so, what that means is more potential acquires are going to be looking at their market, more potential foreign investors are going to be looking at their market.

Tim: Well another thing is once foreign companies start acquiring Japanese companies I think that will spur the Japanese companies.

James: That’s exactly what I was getting to.

Tim: Yeah.

James: Yeah, yeah, so Japanese companies tend to be conservative and I think there is a bit of herd mentality and of course its human nature to have herd mentality, but I think it’s definitely more pronounced in Japan. Half of the Japanese economy is in cash on balance sheets in companies, right? And so, they need to do something anyway because they are being evaluated based on the shame index so they their capital efficiency is what they are being measured on. Right now they are doing share buy backs, but that’s a short-term measure. The long-term measure is to actually use that cash for new business.

Tim: It sounds like the pieces are in place.

James: The pieces are in place. So as long as we can get foreign acquires to set the example, I think that the domestic large corporates that have all of this cash piled up are going to feel like, okay we are going go to have to do something to.

Tim: Right.

James: Yeah.

Tim: So the pieces are in place. Are there specific industries or types of startups that you think Japan is either very strong in now or that they could be strong in the next few years?

James: I mean the obvious answer is hardware based.

Tim: Traditionally?

James: Right, it has been and for hardware to be an interesting business you have to build some sort of interesting software layers as well, right to build it into a business, because a lot of ways hardware is kind of commoditized.

Tim: So we are looking at an internet of things, type, or place?

James: It could be an internet things, but the best example I like for that is like Dropcam. So Dropcam it’s just a camera, right, but you can do all sort of interesting things, like for example you just access it from your smart phone and they monetize by making you pay if you want to see the historical video like the past, I don’t know what the timeline is, but for example if you want to access something six months beforehand you can pay monthly.

Tim: Alright.

James: So it’s like a cloud storage, that’s basically it so the business is not the cameras itself but it’s the cloud storage. Then they have other things like they can recognize things based on what’s in the video, like your dog walks by, whether there’s actually a burglar coming in, you know, things like that. And so the software part is the interested part, but the hardware is what’s important because that multiplies what you can do with the software.

Tim: Um.

James: So, right now there’s sort of a shift where creating hardware companies has become a lot easier, right? There was a shift where software all of a sudden became very easily to build or at least cheap to build.

Tim: Yeah.

James: There is a similar thing happening in the hardware space, where you have streamline manufacturing products such as; 3D printing sensors are cheaper and all sorts of things. So it’s a lot easier to get that sort of iteration that was important in software too, right? Then you have Kickstarter for example that can get you off the ground and build validation so that investors can actually feel like they are comfortable that they can put this much capital into hardware, capital intensive company. Anyways, I think there’s a lot of promise for that. I also thing that because these hardware companies are doing layoffs and also not necessarily building the most innovative products. There’s probably a lot of really frustrated engineers that want to do something.

Tim: This is one thing that I’ve noticed, I think that Japan does have advantages in this space in that a lot of the hardware startups in the US are smart guys in their 20s. A lot of the hardware startups in Japan, okay they will have a couple of smart guys in their 20s, but they will also have someone who’s been at Sharp or Sony for the last 30 years and understands quality assurance and outsourcing and it’s going to be interesting to watch.

James: Yeah, that’s for sure. Yeah we are excited. Our general approach is that we just want to meet a lot of smart, vicious entrepreneurs so we try not to focus too much on different sectors, but of course we each have our biases.

Tim: So one of the things 500 Startup brings is that access to the global market and the global exposure and every startup founder in Japan is lip service to going global.

James: Mm-hmm.

Tim: Do you think that most Japanese startups are really ready to go global? Do you see them taking the necessary steps to address a global audience? Or do you think Japanese startups are still too focused on the domestic market right now?

James: There’s a few components to answer that question. The first component is; when you start a company in Japan you have to decide from the beginning is it going to an English speaking company or is it going to be a Japanese speaking company. In the long-term you might have more growing pains, if you start as an English speaking company, but once you get over that it’s a lot easier to go global, because you have global in your core. English is a global language and so it’s a lot easier, right? But on the other hand in the early days when you need to move quickly and you just need talent it’s pretty hard to find bilingual staff, not only that, they are likely more expensive.

Tim: Yeah.

James: One of the barriers for some of these Japanese startups that want to go global, they are not global from the core and so what ends up happening you go to some of these, I won’t name names, but you go to San Francisco office of this big startup, at least big for Japanese standards, and everyone is Japanese there.

Tim: Oh you mean a San Francisco office of a Japanese firm?

James: Of a Japanese firm and everyone is Japanese and you’re like

Tim: What are you doing guys?

James: Yeah, well I mean you need to hire a local executive that understands the market, has built relationships, you know, especially if its sales oriented. It just blows my mind they don’t have that sort of common sense and they choose to go with someone that speaks Japanese or someone that’s like they feel like they can go drinking with this person.

Tim: Although I’ve done a lot of market entries for foreign companies in Japan, that problem is universal.

James: Yeah it’s universal. So I mentioned that in Japan, when I was speaking there, that is universal so it happens both ways. That’s true.

Tim: Yeah. Do you find that Japanese startups are aware of the foreign competition?

James: So they probably wouldn’t. They would do maybe a simple Google search, but also there is no one on the founding team that has that capability and that’s another problem. One thing that is kind of going to be a challenge for us is that we want to get bilingual people to see that they have such an advantage over the competition locally, because they have all of this extra information available to them. There is sort of this arbitrage opportunity were not only can you do time machine type of models where it’s like a similar model from somewhere else and bring it to Japan, but you get updates on what’s going on in the global perspective in real time.

Tim: That’s another very disruptive thought because traditionally, most Japanese who speak English and are working for a large corporation keep that fact to themselves.

James: Yeah, yeah, they do.

Tim: It can be viewed as somehow mistrusted or more likely they will get a lot of translation work shoved at them.

James: Ha-ha, yeah. Well the other thing is that bilingual talent in Japan, we have it pretty easy, I mean, no matter what we do someone is going to hire us because we are in high demand.

Tim: Right.

James: So you are so complacent that you just that you just don’t feel you like you don’t want to push yourself anymore. No matter what I do I’m going to be working at this brand name company and have a pretty good salary, Japan is just a nice place to live. Why would I dive into a startup? It just doesn’t make any sense.

Tim: Yep. Having a fall back is dangerous.

James: It is dangerous

Tim: It’s definitely a two-edge sword. So the amount of investment capital in Japan and the number of investible companies in Japan is much smaller than it is in the US. Do you think it’s a demand side problem that there’s not enough investors to claim capital? Or do you think it’s a supply side problem where there’s just not enough creative entrepreneurs building something worth wild and willing to take a risk?

James: It’s a little of both.

Tim: So it’s kind of a chicken and egg problem?

James: It is kind of a chicken and egg problem. The companies that are good, if venture funding in Japan, including Angel Investment is like 1.2 billion, you can’t expect them to compete with the US where it’s 75 billion.

Tim: Right.

James: They are just going to under capitalize, that’s just fundamentally not able to compete, right? That’s one thing. The other thing is unicorn is a popular term, right? Companies here tend to go public very, very early and so like I said, it’s the series B. If they go public they immediately have to answer to shareholders and it’s very expensive. They’d have to think short term and so you are kind of pressured to become profitable right away as long as your economics make sense you should be focusing on growth, so that as long is at some point you can turn on the switch and say okay we’re going to be profitable now.

Tim: US companies used to go public a lot earlier than they do now.

James: Yeah, and I’ll explain to you why that’s the case. So let’s say around 2002, 2003, when was Sarbanes Oxley?

Tim: Around there.

James: Yeah, so around then the average age of a company that goes public was about three years.

Tim: Really?

James: Yeah.

Tim: Huh.

James: Then you had Sarbanes Oxley and all of a sudden it became such a pain in the ass to go public so now it’s like twelve years or thirteen years.

Tim: Really?

James: When you think of a life of a venture fund is ten years it’s insane, right?

Tim: So it’s kind of a chicken and egg problem. Is it balanced? There’s enough financing to finance the worthwhile companies, there’s enough worthwhile companies to meet the demand?

James: Yeah. Going back to the chicken and the egg thing, the good companies are undercapitalized, so inevitably their evaluations don’t become as high as you’d like and so that affects upside for smart people to start companies, right?

Tim: Right.

James: So the exit values are much lower. However, we think that if we can increase the number of exits, that drives returns to not only investors but to entrepreneurs and so suddenly you are going to have these twenty-somethings, thirty-somethings, that have like millions of dollars, you know and driving around in a Ferrari for example. I think that’s going to, as long as the drive to do something new is genuine and not just some MBA that’s just chasing what’s new and hot. I think that’s going to make people feel like they have a fighting chance. On the upside it’s going to be much higher if they actually started a company.

Tim: Okay. So it sounds like things are reasonably well-balanced now, there’s enough investors to invest in the quality startups, there’s enough new startups to satisfy investor demand, and it sounds like the pieces are in place for it to grow organically from here.

James: Yeah, I think the timing feels right, which is exactly why were are launching this fund.

Tim: Okay, that’s great! I’m looking forward to seeing 500 Startups disrupt Japan in this way. You mentioned before about Japan being a very opaque market.

James: Yes

Tim: Observers overseas have very little visibility into it. What do you think is the biggest misconception that Westerners have about Japan and about the Japanese startup ecosystem?

James: I don’t think it’s a misconception. I think it’s more of no perception.

Tim: They just don’t know?

James: They just don’t know.

Tim: I got it.

James: There is just not enough visibility here that it’s not even on the radar.

Tim: Okay, well hopefully you guys are going to be changing that.

James: That’s our hope.

Tim: Sooner rather than later. Let me ask you, if I gave you a magic wand and said you can change one thing about Japanese society, anything at all to make it better for startups and entrepreneurs here, what would you change?

James: Okay, so I have two but since you’ve already mentioned the failure thing before, about the acceptance of failure in Japan, what I’m going to add is it just seems like in the US there is more of an acceptance towards breaking down the old and building the new.

Tim: Okay.

James: Whereas in Japan, as you know, some of the oldest companies in the world, most of them are Japanese, right? So these companies that have been there for hundreds of years, there’s sort of this respect for the establishment and what’s already big don’t change it, it seems to be working, what’s broke, don’t fix it.

Tim: So people need to kind of question the way things are more?

James: I think in the US people are perfectly fine with forgetting about that old dinosaur and just like building it from the ground up, just build it from zero to one. I think that mentality needs to change in Japan where they are rooting for the underdog because it’s a better way of doing things.

Tim: That is really interesting and I think that there is a big difference between startups here in Japan and in San Francisco.

James: Yeah.

Tim: In San Francisco, everyone is talking about taking down Microsoft or IBM and in Japan it’s still pretty rare.

James: Yeah.

Tim:Fujitsu now there are going to be out of business in twenty year.

James: Ha-ha, yeah. Yeah, no, it’s true though. I mean that’s absolutely the case and I think people need to be more confident about the fact that these do move slowly and there is a chance to fight these guys and be perfectly okay with that. I mean be okay with a new beginning.

Tim: Do you see the seeds of that now? Do you see some of that starting in Japan?

James: I do. I mean, like I said, think that there are certain people that have that ambition and are fighting those people that are pushing them down, right? It’s like the nail that sticks out gets hammered down. They are fighting the hammers.

We are back. I think James point about the importance of empathy is a great one and I wish we had more time to really do it justice during the interview. It’s a shame, but in business and in finance in particular, empathy is often seen as a sign as well, weakness really, but it isn’t.

In VC investing, it’s a definite strategic advantage. You see, despite the betrayals and the media, growing a company is really difficult and emotionally draining. A VCU is partners who have been through that process, who understands what the founders are going through on the inside and can help them get through it are not just being nice guys, they will have a far more profitable portfolio and they will see much higher returns. Huh, I bet that friends from back in the Hedge Fund days would laugh at me for asserting that empathy is a secret to investment returns, but it is. I think James nailed that one.

I came away from our discussion in a very optimistic mood. The pieces are in place to see an increased amount of M&A and venture investment and it seems that James has a plan for kicking off a virtuous cycle of increasing quality of startups and availability of capital.

Over the next few year I’m looking forward to seeing James and 500 Startups disrupting Japan. If you’ve got an experience with Japanese VCs that you want to share, come on by DisruptingJapan.com/show033 and tell us about it. Or drop by the Disrupting Japan Facebook page and we’d love to hear from you.

When you drop by the site you will see the links and sites that James and I talked about and much, much more in the resources section of the post. If you get the chance, please leave us an honest review on iTunes. It’s really the best way you can support the show and help us get the word out.

Most of all, thanks for listening and thank you for letting people interested in Japanese startups know about the show.

3 Comments

Thank you for the interview and the nice perspective. There is one thought that I can not shake: It is complicated/annoying for established, funded companies to hire foreign staff but it is very hard to do as a startup. To hire a foreigner willing to live and work at your startup you need to have a visa usually, however the usual profile of a engineer or designer that would work at a startup does not fit the japanese law of “expert visa” (or any other really). So you are left with engineers that are married to japanese persons and those are in need to provide a salary (a lot of japanese wifes are risk averse as well…). What is your (or James’s) recommendation to a startup willing to hire a foreigner without a visa? Could 500 startups or DeNA have enough power to change this particular law?

Thanks for listening, and thanks for your comment. I’ve sponsored a lot of visas at my companies in the past. It’s kind of a pain, but it’s not that hard if the engineer has a four year degree and is from a developed country. No degree and/or coming from a poorer country makes it significantly harder. A lot of foreigners here are working on a contract basis, and while that is not technically legal, everyone seems to let it pass. It’s definitely not a long-term solution.

I don’t see the law changing anytime soon. However, the government has recently created a new visa category for those who are starting a company that lets founders stay here for a few months while they establish their company and get funding. They can then have their company sponsor themselves.

Japanese immigration system is surprisingly open to high-skilled workers.